New pension accounting rules don't justify cuts

November 1, 2013, 9:35PM

11/01/2013

New accounting rules set by the Governmental Accounting Standards Board underscore the need to address the California State Teachers' Retirement System's $70 billion unfunded liability, but they should not be distorted to portray a sky-is-falling scenario.

Yet those who would like to see the new rules inappropriately used to justify draconian cuts to educator pensions would have you believe exactly that.

For nearly 10 years, CalSTRS has made considerable effort to call attention to its unfunded liability, which is the outstanding debt for projected future benefits and the risk of not addressing it. The new GASB accounting standards, which take effect for CalSTRS this year, don't change this situation. What they do offer is an incentive to act.

Pension funds must calculate the total value of all member benefits to provide adequate funding, and amortize this amount in much the same way banks amortize home loans. This process or calculation is what allows you to make predictable monthly payments.

Until now, how governments funded pensions matched how they reported them in financial statements. GASB changes this relationship. The effect of this shift has caused consternation in financial reporting. Confusion between the numbers used to project funding needs and those used in financial reporting further cloud the issue.

Outside of financial statements, however, the GASB standards do not provide relevant information to governments struggling with how to address unfunded pension liabilities. In fact, GASB has said that it does not intend for policy makers to use the new accounting requirements as part of the governmental budget process.

The greatest controversy centers on the use of a blended discount rate that must be applied when pension funds like CalSTRS are projected to run out of assets. Discount rates are what pension funds use to discount future obligations for current benefits.

CalSTRS uses a 7.5 percent annual rate of return on its investments to forecast earnings, discount future obligations and to determine any unfunded liabilities. CalSTRS has achieved average earnings at this rate for the past 20 years. Under the new GASB standards, CalSTRS will report a drastically lower, blended rate based on a complex calculation currently equal to 4.85 percent.

GASB's calculation is the equivalent of a worst-case scenario that does not factor in the benefit of additional contributions or active investment gains and is designed for a plan whose contributions and assets are theoretically frozen. Using GASB's approach more than doubles CalSTRS' approximately $70 billion unfunded liability for accounting purposes only, to $167 billion.

Any attempt to restore CalSTRS' long-term viability based on the GASB standards overly inflates the amount of contributions needed from members, school districts and the state, needlessly subjecting them to significant and unnecessary financial strain.

It's important to understand CalSTRS' risk of facing depleted assets exists approximately 30 years from now rather than actually facing insolvency today. The contributions paid by CalSTRS members, employers and the state are sufficient to cover the ongoing costs of the benefit program. But the impact of two major financial downturns in less than 10 years, and the continuing failure of the state and employers to pay the annual amount required to eliminate the shortfall, has negatively affected the fund.

Unlike other California pension plans, the CalSTRS board lacks the authority to raise contribution rates to shore up any funding deficiencies — only the Legislature and the governor can do that. In order for the fund to invest its way to financial health, CalSTRS estimates it would need a more than 10 percent investment return each year for the next 30 years to achieve full funding by about 2043.

GASB's rules don't change CalSTRS' funding status, nor should they be used to slash modest educator benefits. Instead, they serve as an impetus to take responsible, immediate action. The state auditor suggests in a recent report that addressing CalSTRS' funding status, which is characterized as a high-risk issue, is top priority. The fiscally sound approach to sustain the long-term viability of the fund is a gradual, predictable increase in contribution rates, equitable to all parties involved.

The Legislature and governor, however, must tackle the challenge of crafting a specific funding strategy since only they have the authority to do so, and the state's general fund is at risk without one.

<i>Jack Ehnes is chief executive officer of the California State Teachers' Retirement System.</i>

New accounting rules set by the Governmental Accounting Standards Board underscore the need to address the California State Teachers' Retirement System's $70 billion unfunded liability, but they should not be distorted to portray a sky-is-falling scenario.

Yet those who would like to see the new rules inappropriately used to justify draconian cuts to educator pensions would have you believe exactly that.

For nearly 10 years, CalSTRS has made considerable effort to call attention to its unfunded liability, which is the outstanding debt for projected future benefits and the risk of not addressing it. The new GASB accounting standards, which take effect for CalSTRS this year, don't change this situation. What they do offer is an incentive to act.

Pension funds must calculate the total value of all member benefits to provide adequate funding, and amortize this amount in much the same way banks amortize home loans. This process or calculation is what allows you to make predictable monthly payments.

Until now, how governments funded pensions matched how they reported them in financial statements. GASB changes this relationship. The effect of this shift has caused consternation in financial reporting. Confusion between the numbers used to project funding needs and those used in financial reporting further cloud the issue.

Outside of financial statements, however, the GASB standards do not provide relevant information to governments struggling with how to address unfunded pension liabilities. In fact, GASB has said that it does not intend for policy makers to use the new accounting requirements as part of the governmental budget process.

The greatest controversy centers on the use of a blended discount rate that must be applied when pension funds like CalSTRS are projected to run out of assets. Discount rates are what pension funds use to discount future obligations for current benefits.

CalSTRS uses a 7.5 percent annual rate of return on its investments to forecast earnings, discount future obligations and to determine any unfunded liabilities. CalSTRS has achieved average earnings at this rate for the past 20 years. Under the new GASB standards, CalSTRS will report a drastically lower, blended rate based on a complex calculation currently equal to 4.85 percent.

GASB's calculation is the equivalent of a worst-case scenario that does not factor in the benefit of additional contributions or active investment gains and is designed for a plan whose contributions and assets are theoretically frozen. Using GASB's approach more than doubles CalSTRS' approximately $70 billion unfunded liability for accounting purposes only, to $167 billion.

Any attempt to restore CalSTRS' long-term viability based on the GASB standards overly inflates the amount of contributions needed from members, school districts and the state, needlessly subjecting them to significant and unnecessary financial strain.

It's important to understand CalSTRS' risk of facing depleted assets exists approximately 30 years from now rather than actually facing insolvency today. The contributions paid by CalSTRS members, employers and the state are sufficient to cover the ongoing costs of the benefit program. But the impact of two major financial downturns in less than 10 years, and the continuing failure of the state and employers to pay the annual amount required to eliminate the shortfall, has negatively affected the fund.

Unlike other California pension plans, the CalSTRS board lacks the authority to raise contribution rates to shore up any funding deficiencies — only the Legislature and the governor can do that. In order for the fund to invest its way to financial health, CalSTRS estimates it would need a more than 10 percent investment return each year for the next 30 years to achieve full funding by about 2043.

GASB's rules don't change CalSTRS' funding status, nor should they be used to slash modest educator benefits. Instead, they serve as an impetus to take responsible, immediate action. The state auditor suggests in a recent report that addressing CalSTRS' funding status, which is characterized as a high-risk issue, is top priority. The fiscally sound approach to sustain the long-term viability of the fund is a gradual, predictable increase in contribution rates, equitable to all parties involved.

The Legislature and governor, however, must tackle the challenge of crafting a specific funding strategy since only they have the authority to do so, and the state's general fund is at risk without one.

<i>Jack Ehnes is chief executive officer of the California State Teachers' Retirement System.</i>